About the author

James Pethokoukis is a columnist and blogger at the American Enterprise Institute. Previously, he was the Washington columnist for Reuters Breakingviews, the opinion and commentary wing of Thomson Reuters.

Asking ‘Can the Fed fix the economy?’ is really the wrong question

Not to pick on economist Diana Furchtgott-Roth, but her MarketWatch column hits on a theme that I have seen a lot of — and expect to see a lot more of as the Janet Yellen nomination for Fed chair moves through the Senate confirmation process. DFR: “What will Janet Yellen, the nominated chairwoman of the Federal Reserve, do to fix the economy? Not much, it appears, if she is wedded to accommodative monetary policy and a continuation of Fed Chairman Ben Bernanke’s regime.”

1. Does DFR think the Fed is an obstacle to recovery? More likely, I think, that the Fed’s latest QE bond-buying has helped offset significant fiscal austerity. Economist Mike Darda:

The fact that austerity appears to have been self-defeating in the euro area while the most rapid fiscal consolidation since the Korean War demobilization in the U.S. has been met with steady growth is a critical testament to the fact that the Fed has been more adept at offsetting demand/velocity shocks than the ECB.

2. Straw man argument alert! I don’t think anyone at the Fed believes monetary policy can fix structural problems or increase the US economy’s growth potential. I know I sure don’t. That stuff needs to be fixed with pro-growth, pro-innovation “supply-side” remedies such as tax, regulatory, and education reform of the sort DFR and I probably mostly agree on. But the Fed can meet increase money demand and provide a stable macroenvironment. Economist David Beckworth:

The way QE is working is by addressing the ongoing, elevated demand for liquidity. The Fed is partially accommodating this demand which then leads to more spending. Evidence of this demand can be seen by the fact that about 85% of US marketable debt—the most liquid asset other than US dollars—is held by individuals, their financial intermediaries, and foreigners. In other words, about 85% of the largest run in public debt continues to be supported by entities other than the Fed. Now, interest rates on treasuries have gradually risen over the past year indicating some of the liquidity demand is easing (i.e. less demand for treasuries lowers their price and raises their yield), but there is still a long ways to go. Other evidence for this ongoing demand for liquidity is that households still hold a relatively large share of their assets in liquid form.

Discussion: (6 comments)

1. Fiscal consolidation came from TARP $ and dollars created into existence by the FED. As I have explained before the real value of the assets has not increased (stocks, real estate in particular) only the price of capital items. Not sure how we would weed out the artificial from the real recovery, but as the FED itself says, IT is responsible for most of the stock price run up, and thus, it has manufactured money to float Wall St and the big banks. Moreover, the FED continues its own toxic assets program, creating money out of nothing to absolve banks from responsibility for their often fraudulent behavior in writing bad loans and producing derivatives that are even more fraudulent. This transfers wealth from the truly productive to a blood sucker elite that only is successful because of its political ties, and its ties to the FED who create the money to drive the sale, to pay the commissions to “earn” the bonuses for management. All based on a sytem of fraud.

How is rewarding banks and Wall St for irresponsible and even fraudulent bahavior a deterrent to a future of more of the same?

To the extent that the left addresses these issues, which it seldom does as it has a vested interest in keeping the merrygoround going, they are correct in decrying concentration of wealth in this manner, as opposed to providing real goods and services that people are willing to pay for so that they can make a profit.

Note also that the European “austerity” is more of a chimera than a reality. They have not cut much, especially in view of how bad their economy is and how grossly overspent governments over there are. Note also that the FED creates dollars to also keep the EU afloat. More house of cards building. Rue the day when these inflationary dollars come to the only place they will have value if the dollar loses its position as world reserve currency, that is, back to the US.

2. Agree in part with comments in this section. The FED can not solve structural problems, but one remedy you left out:liquidation of untenable assets, of companies that are in reality bankrupt. To float them with more “liquidity” (translation-counterfeit money) is to merely postpone the day of reckoning. While the downturn of 2001 was painful, to let the market work rather than “create the liquidity with which to float the markets” Al Greenspan- was to kick the can down the road and suffer a deeper and longer correction. NO lessons learned from the 1930’s here. And as bad as the 2008-9 recession was, in all likelihood, you ain’t seen nothin’ yet, as we kept alive many of the cripples that should have been liquidated, and ultimately will be (GM ANYONE?)

Demand for liquidity? Would that not be reflected in higher interest rates in a free(r) market? And yet the FED creates all the money the market needs, stealing the wealth of those who got theirs by providing goods and services at a profit and have dollar denominated assets, CDs, bank notes, passbook savings. JP would punish the most frugal, the most sound parts of our economy to create “liquidity.” And note again, much of that liquidity, about half a trillion per yr, goes to financial services industry, if not more.

85% of fed bonds held by other than the FED- ok, but do not forget that the FED parked at near zero interest, TRILLION$ to the accounts of the big banks, the banksters as I like to call them and much of that was directly invested in government bonds, allowing the fedgov to continue to shirk its sense of fiscal responsibility, and enslaves our children to the banksters , for they will have to pay these debts.

BOy am I glad I came here for enlightenment. OOOPS> I meant “entertainment.”

Not to mention, the house of cards is likely to come tumbling down a lot faster than it was built.

Well, actually right now the Fed could do a lot more for economic growth. Sure, structural impediments blah-blah. But this 2008 bust was a financial recession-deflation. There was no sudden increase in structural impediments in 2008. The Fed needs to show steel and resolve for growth.

The best the fed can do is make sure it’s not in the way of real economic growth. I hold my nose and accept that the goal of TARP was correct, to keep the system liquid. The real problem I have with it is that it was not used to buy time to allow the “too big to fail” banks to go into an organized bankruptcy and turned their profitable and necessary business over to the stronger regional banks out there who maintained some semblance of respect for the concept of moral hazard. The crony capitalist wall street fat cats would have taken the haircut they so richly deserved, the competent bankers who eschewed the easy tainted money would have rightfully prospered, the banking system would have survived, and the economy would have recovered stronger and better than it has.

The best the Fed can do is make sure it’s not in the way of real economic growth. I hold my nose and accept that the goal of TARP was correct, to keep the system liquid. The real problem I have with it is that it was not used to buy time to allow the “too big to fail” banks to go into an organized bankruptcy and turned their profitable and necessary business lines over to the stronger regional banks out there who maintained some semblance of respect for the concept of moral hazard. The crony capitalist Wall Street fat cats would have taken the haircut they so richly deserved, the competent and responsible bankers who eschewed the easy tainted money would have rightfully prospered, the banking system would have survived, and the economy would have recovered stronger and better than it has.

I am reluctantly of the opinion that the wild card in our current situation is Obama. The health care situation is flawed by design, making the premiums too high for many if not most of us to pay, thus pushing us into govt-provided ‘health care’ and making the feds the ultimate socialized provider of services. As a corollary, the value of the dollar will be decimated, further weakening our economy.

With our industrial capacity already going and gone, we will have nothing to export, thus humbling the US even further. Destruction of the base of the US economy, reducing us to the level of a failed banana republic, would seem to fit nicely with Obama’s intention to rid us of our American arrogance.

There is purpose to his apparent lack of understanding of how world economics and trade function: weaken the US far enough, and our economy will collapse. Bill Ayers and Saul Alinsky would be proud.